C2: Certainy equivalent

[Original Man]

I know its late but I have a last minute question. The eqt'n for a certainity equivalent cash flow is Earnings/1+r= CF/1+rf. Is the r, the return on equity or the firm's opportunity cost of capital or should there be some particular wording in the question that signals either one?

PS Good luck to everyone writing the course 2 (actually, only to 30% of you) :wink:

[Macroman]

What is your source for this equation?

You shoud be able to tell by context of the question. r should be the rate of return associated with the the cash flow or income in the numerator. As far as that goes it could be any risky income, bond interest, gambling winnings, whatever. In general these would be expressed as sums, your equation is the single cash flow single period version.

You should get in the habit of putting parentheses around those denominators.

[Avi]

In May 2000, there was such a question and it asked for the CE of the earnings available for equity, so the proper denominator was 1+r_E. (You had to reverse engineer the WACC to get it).

I would presume that if they just referred to a companies cashflow and did not tell you whethwr it was specifically debt or equity, that you eould just use the WACC or plain r.

--Avi